Lesson 9: Expense Accounts
Expenses are the great equity killer. Liabilities get a bad rep but expenses do far more damage to your Net Worth. Every single expense transaction incurred directly reduces Net Worth; most with no real chance of ever recovering the loss. Minimizing expenses is key when it comes to maximizing Net Worth.
In the previous lesson, there were four primary asset accounts involved with realized Income transactions. Those same four accounts are the primary asset accounts used to pay for expenses as well, depending on the payment method:
Cash --> Cash Account
Debit card, Check or Zelle --> Checking Account
Digital --> Venmo, Cash App or Paypal Account
Bitcoin/Cryptocurrency --> Crypto Wallet Account
Important Note 1: Always remember that expense accounts are contra (reverse) equity accounts, so increasing them decreases Net Worth.
Important Note 2: For the sake of simple explanation, I just labeled the expense account as "Expense" in Figure 9A. However, in practice you would have a different account for each Expense Type in your life. Below is a complete list of most expense types used in a personal finance accounting system:
The yellow column to the left is the header column and each cell in white represents a different expense account. Every expense related transaction will involve one of these accounts (or others if your personal system requires more). The accounts act as running totals of every penny spent for each expense type. In terms of businesses and corporations, this highlights why accountants & bookkeepers (and accounting software) are so important. They are the ultimate financial organizers that help make sense of millions and billions of transactions. On a financial report, the expense accounts are summarized and totaled by their account headers for simple delivery and interpretation. For example, looking at the Travel row at the very bottom: If your Expense: Hotel account has a balance of $100 and your Expense: Airfare account has a balance of $200, a financial report would simply show $300 worth of total Travel Expenses.
From Figure 9B you can see that the list of general Expense accounts is pretty large. Obviously, each of us does not use every single one listed but there is a good chance most of use at least a quarter of those annually. No matter the amount of expense accounts in our accounting systems, the mechanics remain the same across them all. i.e The accounts titled "Expense" that were debited in Figure 9A can easily be swapped with any expense type from Figure 9B. To show you what I mean, we will revisit Lesson 7 Example 2 in which you spent $250 on general expenses. Only this time, we will go into more detail on the expense accounts.
Example 9-1: You use your debit card to spend $75 on groceries, $25 on fuel for your car, $100 on new clothes, and $50 on a spa day gift card for your lover. Here is the affect on your Balance Sheet as a result:
Left (Asset) Side: Since a debit card was used (not to be confused with debit entry), each transaction decreases your Checking Account, resulting in four credit entries totaling $250.
Right Side: Since you had four transactions with different expense types, four different accounts are involved. When all debit entries are totaled, they offset the total debits on the left side and decrease Net Worth by $250.
Assets = Liabilities + Equity
($75)+($25)+($100)+($50) = $0 + ($75)+($25)+($100)+($50)
($250) = ($250)
Important Note 1: The asset account used just depends on the payment method. For example, if you used cash from your wallet to pay for everything, the credit entries would have been applied to the Cash Account instead.
Important Note 2: Notice that the $50 gift card to the spa is categorized to the 'Gifts & Donations: Gifts' account instead of the 'Personal Care: Spa & Massage' account. These are the nuances of bookkeeping; deciding which account is the right one. Since this transaction is a gift for somebody it is not personal care for you. Therefore, it is applied to the Gift Account and not a Personal Care account. That one is kind of obvious when you think it through but there can be many transactions that fall in gray areas. Just be consistent with your Expense types and your books will always be accurate and serve their purpose. There is a later lesson that gives guidance on how to deal with some of these nuanced situations.
The large majority of your personal finance bookkeeping is focused on tracking expenses. There may be days where you have 10+ different expense transactions and each one requires entry into your accounting system. If you fail to enter them then incur 5 more transactions the next day, you are now 15 transactions behind. Getting behind kills your books and can ruin your budget. Stay up to date with your expense entries and you will always have a good picture of your financial standing. In addition to having a real-time financial picture, you will also have actual historical numbers to base future budgets on.
How much have you spent on groceries this year? How much have you spent on clothes this year? What is your average monthly total for utilities? What are the budget amounts for your expense types that will enable you to save enough to invest in stocks and grow your Net Worth? If you can't produce the answers to these questions then you need to update your books. If you do not have a set of books tracking your financial activity and Net Worth, then you need to change that!
Click here for the next lesson on accounting/bookkeeping for auto loans.